Slovakia gained approval from the European Union to allow the koruna to strengthen beyond the rate the country agreed as a condition to adopt the euro.
The EU will lift the koruna's so-called central parity rate 8.5% to 35.4424 against the euro from March 19, Slovak Finance Minister Jan Pociatek said yesterday in a phone interview from Bratislava. The koruna is allowed to trade 15% above or below the rate under conditions Slovakia must meet before it can join the 13-nation euro region. Greece was the last country to revalue within Europe's exchange-rate mechanism in 2000. "The revaluation is fully justified,” Pociatek said. There's been "a significant strengthening of” the currency. The koruna has rallied 10% against the euro in the past year, more than any other currency, as companies including PSA Peugeot Citroen and Kia Motors Corp. opened factories and economic growth accelerated to a record.
The central bank sold the koruna as recently as March 8 to try to curb its gains. "The central bank doesn't really have the resources to intervene on a regular basis,” said Dwyfor Evans, an emerging markets analyst at Bank of America Corp. in London, before the announcement. The country holds $14.7 billion in foreign-currency reserves to defend its exchange rate, equivalent to the cost of about four months of imports. In comparison, Russia has about $300 billion in reserves, or about two years worth of imports.
Slovakia aims to become the latest former-communist country to join the 13-member euro-region after Slovenia, which adopted the currency this year. Lithuania, Estonia and Latvia had to push back timetables for adopting the euro because their inflation rates were above limits set by European authorities. The revaluation will "support the authorities in maintaining macroeconomic stability,” the EU said in a statement released from Brussels late on Thursday. "The revaluation is based on a firm commitment by the authorities to pursue appropriate supportive policies” including tackling wage pressures and credit growth,” the EU said.
Moving the central rate will allow Slovakia's central bank to use currency appreciation as a tool for slowing inflation instead of selling its currency for euro on the market or cutting interest rates, economists said. "They did it now to avoid the situation when the koruna would be too close to the upper boundary of the band,” said Juraj Kotian, an economist at Slovenska Sporitelna AS in Bratislava. "The new rate reflects the change in the parameters of the economy since” it went into the exchange-rate mechanism. Kotian said a rate cut at a time of fast economic growth could "worsen the inflation outlook.” The koruna rose 0.1% to 33.930 to the euro yesterday, or 11.8% above the previous central parity rate of 38.455.
Allowing the currency to strengthen further will help damp inflation by lowering the cost of imports for consumers. The central bank, Narodna Banka Slovenska, on March 13 rejected a third of offers at a weekly sale of repurchase agreements to increase the amount of excess koruna at commercial banks and reduce pressure on the currency to rise. To adopt the euro, a country must slow inflation to within the average of the three EU countries with the lowest 12-month inflation rates plus 1.5 percentage points. Slovakia's 12-month inflation rate was 3.9% in February and to qualify it will need to squeeze the rate further. The estimated ceiling for euro adoption was 2.9% in February and a country's 12-month inflation rate must be in line in the year it files a bid, along with an outlook that inflation is not expected to rise.
Annual inflation in Slovakia fell to 2% in February from 2.2% the preceding month as the effect of last year's increases in global energy prices waned. The central bank estimates the rate will fall to 1.5% in December. The economy grew a record 8.3% last year, buoyed by increased foreign direct investment and manufacturing. Peugeot Citroen, Europe's second-biggest carmaker, and Kia Motors, a unit of South Korea's biggest automaker, have opened factories. Against the dollar, the koruna has strengthened 20% in a year. Slovak government bonds have risen 26.8% in dollar terms, second only to Thai debt, according to indexes of 27 emerging-market debt securities compiled by JPMorgan & Co.
Decision was announced following a meeting of the Economic and Financial Committee in Brussels yesterday. The panel includes representatives from the national banks in the euro region as well as the other countries in the ERM and finance ministries and the European Central Bank.
Lithuania, Estonia and Latvia plan to slow inflation enough to be able to adopt the euro from 2010. Malta and Cyprus have applied to use the single currency from January 1 next year. The exchange-rate mechanism is one of the five conditions for aspiring members of the euro region and is designed to test the stability of their exchange rates for at least a two year period.